The Oil Company Investors Fear Most

Last week saw another upwards revision in Saudi Arabia’s proved oil reserves, this time via BP (although the figures came from Saudi’s state hydrocarbons behemoth, Saudi Aramco), putting them 11% higher than previously thought at 297.7 billion barrels of proved crude and natural gas liquids as of end-2018. BP’s rationale for increasing the reserve numbers some 30 billion barrels higher than year-ago levels was that it reflects ‘new detail from state-oil giant Saudi Aramco on the classification of its natural gas liquids, or wet gas, as liquid oil.’

Saudi Arabia still apparently believes that such upward revisions makes the prospect of its long-delayed initial public offering (IPO) of at least 5% of Saudi Aramco more attractive to would-be international investors. In fact, there were renewed mumblings from Crown Prince Mohammed bin Salman (MbS) over the weekend that the IPO might occur next year. The reality, though, is that for many seasoned oil and gas industry experts there remains a huge amount of scepticism towards the company and the Kingdom itself.

On the supposed reserves numbers themselves, there has been incredulity amongst many traders and analysts alike for years, which has only increased every time they have been revised upwards. At the beginning of 1989, Saudi Arabia claimed proven oil reserves of 170 billion barrels but, only a year later and without the discovery of any major new oil fields, the official reserves estimate was increased by 51.2% to 257 billion barrels.

By the beginning of 2014, according to the EIA, Saudi Arabia suddenly had approximately 266 billion barrels of proven oil reserves, in addition to half of the 2.5 billion barrels estimated in the Saudi-Kuwaiti shared Partitioned Neutral Zone. In 2019, this figure then increased to 268.5 at the beginning of 2019, according to an audit done by international energy consultancy, DeGolyer and MacNaughton. “It is mathematically impossible that Saudi Arabia’s proven oil reserves figure has actually gone up over the past thirty years, despite Saudi pumping an average of nearly three billion barrels of oil every year from 1973 to the end of 2018 – which totals around 135 billion barrels – and with no new significant oil finds being made during that period,” a senior London-based risk analyst told OilPrice.com.

Concerns over the actual levels of reserves for potential investors in the Aramco IPO were compounded by devastating comments from senior Saudis over the degree to which Aramco – and its future shareholders – would own its own oil and gas ‘concessions’ (consisting of the oil and gas reserves of the Kingdom). In seeking to clarify this question, Aramco chief executive officer, Amin Nasser, said that although the IPO would include the concessions, the actual wells ‘will still be owned by the government...this is the same as before, and there are no changes to that.’

He added that oil and gas production decisions were sovereign matters that would remain with the government. In practical terms, then, this meant that if Saudi Arabia decided that it was going to try again to destroy the shale oil industry - as it did in 2014 by overproducing to crash the oil price - then Aramco shareholders would see huge losses both in dividend payout terms and in the value of the shares. This reinforced the already burgeoning scepticism around how much independently verified data about the company’s oil reserves and operations would be given related to company strategy once the 5% had been listed.

Some of Saudi Arabia’s lies have already come back to haunt it, of course: most notably its perennial overestimation of its ‘spare capacity’ (the volume of extra oil that it can bring on to the market in an emergency as and when required). Saudi stated for decades that it had a spare capacity of between 2.0-2.5 million barrels per day (mbpd), implying the ability to ramp up its production to about 12.5 mbpd in the event of unexpected disruptions elsewhere.

In 2018, the Saudi King himself, Salman bin Abdulaziz al Saud, promised U.S. President Donald Trump that his country could meet the necessary supply increase of 2mbpd on its own. However, even at that critical time, production barely rose above 10.5 mbpd. “It just confirmed what some of us had been thinking since Saudi’s disastrous attempt to destroy the U.S. shale oil industry from 2014 to 2016,” said the London-based risk analyst. “The obvious question had always been: if Saudi had, and has, all of this spare capacity, why didn’t it just turn the taps on full in 2014 when it decided to fully commit to destroying U.S. shale in its tracks before it really got going? The answer was it couldn’t, and can’t, because at most it can pump just under 11 mbpd tops,” he added.

These financial discrepancies alone were enough to postpone the Aramco IPO for three years, but they don’t even scratch the surface when it comes to why investors are concerned. For years, investors have been nervous about Aramco’s role as a funding pool for various socio-economic projects in Saudi Arabia, the existential legal threat it faces from the U.S.’s ‘No Oil Producing and Exporting Cartels Act’, and the ongoing questions over its future tax status. It was MBS who - facing sizeable Saudi budget deficits every year until 2023 at the earliest - first mooted the idea in 2016 that the floating of at least 5% of the Kingdom’s flagship hydrocarbons giant would give the whole company a valuation of US$2 trillion. Since then, he has been looking for a way to save face on the IPO and major upwards revisions of reserves like the one released by BP last week are often signs of him doing just that.

The most recent example of MBS saving face – Aramco’s ‘purchase’ of a 70% stake in Saudi Arabian petrochemicals company, Saudi Basic Industries Corporation (SABIC) for US$69.1 billion – has served only to compound negative would-be investor sentiment for Aramco. “If it looked like a pretty crude accounting trick it’s because it is,” said the London source.

“It involves one state-owned entity [Aramco] buying a stake in another de facto state-owned entity [SABIC] from yet another state-owned entity [the PIF],” he underlined. “Even if Aramco had bought the 30% non-PIF portion of SABIC that’s listed on Saudi’s Tadawul All Share Index, it could be argued that at least Saudi was gaining some new money into its sovereign coffers but this is not the case,” he added. “In addition, overlaying SABIC’s existing senior and middle management with those of Aramco, an antiquated state-owned bureaucracy, will significantly adversely affect SABIC’s operating efficiency and margins,” he told OilPrice.com. On a logistical note as well, he said, Aramco buying a majority stake in SABIC, given Aramco’s existing downstream infrastructure, will lead to enormous duplication of resources – people, offices, equipment, research and development, marketing, and capital employed, amongst others.

Moreover, the move has only served to once again highlight Aramco’s broader operational shortcomings, in this case by causing potential investors to look at the company’s previous disastrous foray into the petrochemicals market through its former petchems and refining arm, the Rabigh Refining and Petrochemical Company (Petro Rabigh). This was floated via an IPO in 2008 and its performance from the outset of its newly listed life was terrible. Within a very short time of the IPO, there were repeated power shutdowns at its main petchems plant and it lost an aggregate US$428 million from its listing in 2008 to 2016, when it finally turned a tiny profit (of US$9.7 million). By the end of its first listed year, shareholders had lost 80% of the funds they had invested in the stock.